Chapter 18 ________________ Real Estate Appraisal

© 2010 by Cengage Learning

Chapter 18

________________ Real Estate Real Estate AppraisalAppraisal

© 2010 by Cengage Learning 2

Purpose and Use of Purpose and Use of AppraisalAppraisal Appraisal:Appraisal:

Informal appraisal:Informal appraisal: Formal appraisal:Formal appraisal:

Set prices, to base loan Set prices, to base loan values, set insurance values, set insurance premiums, set tax premiums, set tax valuesvalues

Estimate of valueEstimate of value Written statement of Written statement of

an impartial opinion of an impartial opinion of value based on value based on analysis of relevant analysis of relevant market informationmarket information


Defining ValueDefining Value Fair Market Value (or just Market Value): Fair Market Value (or just Market Value):

the cash price that a willing buyer will pay to a the cash price that a willing buyer will pay to a willing seller given reasonable exposure of the willing seller given reasonable exposure of the property to the marketplace each with full property to the marketplace each with full information as to the potential uses of the information as to the potential uses of the property and neither under undue compulsion or property and neither under undue compulsion or hardship to act, no impediments as to title or hardship to act, no impediments as to title or terms.terms.

Nebraska common law definition: Nebraska common law definition: the price that someone ready to sell, but not the price that someone ready to sell, but not

required to do so, would be willing to accept in required to do so, would be willing to accept in payment for the property, and that someone payment for the property, and that someone ready to buy, but not required to do so, would be ready to buy, but not required to do so, would be willing to pay for the property.willing to pay for the property.


Defining Value (b) Details of FMV: Details of FMV:

1) marketable title, 1) marketable title, 2) time to close, 2) time to close, 3) motivation, 3) motivation, 4) informed sale/purchase, 4) informed sale/purchase, 5) exposure to market, 5) exposure to market, 6) market terms, 6) market terms, 7) normal consideration (no special 7) normal consideration (no special financing).financing).


Your HouseYour HouseFrom Your PerspectiveFrom Your Perspective


How the Buyer Sees ItHow the Buyer Sees It


How the Lender Sees ItHow the Lender Sees It


How the Appraiser Sees ItHow the Appraiser Sees It


How the Tax Assessor Sees How the Tax Assessor Sees ItIt


Valuation ProcessValuation Process Step by step procedure Step by step procedure refined by the Uniform refined by the Uniform

Standards of Professional Appraisal Practice Standards of Professional Appraisal Practice (USPAP)(USPAP) Define problemDefine problem Conduct preliminary analysis/collect dataConduct preliminary analysis/collect data Estimate highest and best useEstimate highest and best use Estimate land valueEstimate land value Estimate improved property valueEstimate improved property value Reconcile resultsReconcile results Report conclusionReport conclusion


Value ApproachesValue Approaches Market ComparisonMarket Comparison

CostCost

IncomeIncome

Comparable properties Comparable properties recently soldrecently sold

Acquisition of land, Acquisition of land, build improvementsbuild improvements

Based on monetary Based on monetary return a property can return a property can generategenerate


Market Comparison ApproachMarket Comparison Approach

Comps (usually 3 to 5)Comps (usually 3 to 5) Sales records, where to findSales records, where to find AdjustmentsAdjustments

Market differences and time on marketMarket differences and time on market Differences of amenities, physical features, termsDifferences of amenities, physical features, terms

Adjusted market priceAdjusted market price (of each property) (of each property) Correlation process (assign weight to more Correlation process (assign weight to more

similar property)similar property)


Market Comparison Approach Market Comparison Approach - 2- 2

Competitive Market Analysis (CMA)Competitive Market Analysis (CMA) Not an appraisal methodNot an appraisal method Agents use to list and sell residential propertyAgents use to list and sell residential property In Nebraska agents may charge for serviceIn Nebraska agents may charge for service

Select comparable homes Select comparable homes Recent Sales Recent Sales On marketOn market, and , and Off market Off market (note: these would not be (note: these would not be

included in formal appraisal)included in formal appraisal)

Buyer AppealBuyer Appeal No objective adjustments only subjectiveNo objective adjustments only subjective


Market Comparison Approach Market Comparison Approach - 3- 3

Gross Rent MultiplierGross Rent Multiplier Used like CMA for income producing Used like CMA for income producing

propertyproperty Divide Sales Price by Gross Rent of Divide Sales Price by Gross Rent of

comparables equals GRMcomparables equals GRM Multiply Gross Rent by GRM to arrive at Multiply Gross Rent by GRM to arrive at

market price of subject propertymarket price of subject property GRM does not consider vacancies, GRM does not consider vacancies,

expenses, and other expensesexpenses, and other expenses


Cost ApproachCost Approach Determine cost of landDetermine cost of land Determine cost of Determine cost of

buildingbuilding Estimate depreciationEstimate depreciation Compute value of Compute value of

improvementsimprovements Compute value of Compute value of

propertyproperty

Land is valued as Land is valued as vacantvacant

Based on comparable Based on comparable market informationmarket information





propertyproperty

Reproduction costReproduction cost Exact replicaExact replica Same or similar materialsSame or similar materials

Replacement costReplacement cost Today’s prices and Today’s prices and

methodsmethods Equivalent usefulnessEquivalent usefulness Eliminates obsolete Eliminates obsolete

featuresfeatures Square Foot MethodSquare Foot Method Cost HandbookCost Handbook





propertyproperty

Physical DeteriorationPhysical Deterioration Wear and tearWear and tear Acts of natureActs of nature

Functional Functional obsolescenceobsolescence Outmoded/outdatedOutmoded/outdated Curable and incurable Curable and incurable

depreciationdepreciation Economic obsolescenceEconomic obsolescence

External forcesExternal forces AppreciationAppreciation





propertyproperty

Cost of buildingCost of buildingLess: depreciationLess: depreciationPlus: appreciationPlus: appreciation

Value of improvementsValue of improvements

Add: value of LandAdd: value of Land

Value of PropertyValue of Property


Income ApproachIncome Approach Capitalization RateCapitalization Rate Projected IncomeProjected Income Operating ExpensesOperating Expenses Replacement ReservesReplacement Reserves NOINOI Capitalizing IncomeCapitalizing Income DepreciationDepreciation

Income ($18,000)Income ($18,000)Divided byDivided by

Rate ( 9%)Rate ( 9%)EqualsEquals

Value ($200,000)Value ($200,000)



Projected or scheduled Projected or scheduled gross incomegross income Obtained from review Obtained from review

of Rent rolls based on of Rent rolls based on full occupancyfull occupancy

Deduct: vacancy and Deduct: vacancy and collection losscollection loss



Consider past expense Consider past expense historyhistory

Consider future Consider future expensesexpenses

Do not add capital Do not add capital improvements (new improvements (new amenities)amenities)

Estimate annual Estimate annual amount to replace amount to replace certain itemscertain items



Perform I/R=V Perform I/R=V computationscomputations

Consider mortgage Consider mortgage expenseexpense

Consider effect of Consider effect of depreciation and depreciation and fictional depreciation fictional depreciation (tax write-off)(tax write-off)


Building Sales Price GrossAnnualRents

Gross RentMultiplier

No.1 $245,000 $34,900 = 7.02

No.2 $160,000 $22,988 = 6.96

No.3 $204,000 $29,352 = 6.95

No.4

As a Group:

$196,000

$805,000

$27,762

$115,002

= 7.06

= 7.00


Step 1: Estimate land as vacant $ 30,000

Step 2: Estimate new construction cost of similar building $120,000

Step 3: Less estimated depreciation -12,000

Step 4: Indicated value of building $108,000

Step 5: Appraised property value $138,000 by the cost approach


Income / Rate = Value

$18,000 / 0.09 = $200,000

Variation by Direct Capitalization


Operating expense ratio: $31,070 / $79,800 = 38.9%


IncomeOverall Rate

= Value

$45,4000.09376

= $484,215


Choice of ApproachesChoice of Approaches Market ApproachMarket Approach

Cost ApproachCost Approach

Income ApproachIncome Approach

Will produce values best Will produce values best for residential propertyfor residential property

Ideal when number of Ideal when number of comparable properties comparable properties soldsold

New construction may New construction may not be represented by not be represented by comps comps





Used to value property Used to value property without compswithout comps

Used to value property Used to value property without income streamswithout income streams

Used to value property Used to value property recently constructed or recently constructed or with “standard” with “standard” constructionconstruction





Properties used for Properties used for investment purposesinvestment purposes

Apartment buildings, Apartment buildings, shopping centers, office shopping centers, office buildingsbuildings

May be price per unit May be price per unit (apartment) or price per (apartment) or price per square footsquare foot

May also determine if May also determine if cheaper to build than buycheaper to build than buy


Reconciliation and Reconciliation and EstimateEstimate

Apply weight to each method as best fits Apply weight to each method as best fits the perceived market or the projectthe perceived market or the project

Add the weighted valuesAdd the weighted values Arrive at Best Estimate or Opinion of ValueArrive at Best Estimate or Opinion of Value NOTE: NOTE: An appraisal does not take into consideration the An appraisal does not take into consideration the

seller’s circumstances, or other subjective motivation. No seller’s circumstances, or other subjective motivation. No guarantee of sale at appraised value nor guarantee of guarantee of sale at appraised value nor guarantee of condition of property or future value. Not a loan guarantee condition of property or future value. Not a loan guarantee (though may establish loan to value ratio), nor an Offer to (though may establish loan to value ratio), nor an Offer to

purchase.purchase.


Market Approach $180,000 x 75% = $135,000

Cost Approach $200,000 x 20% = $ 40,000Income Approach $160,000 x 5% = $

8,000

Final Indicated Value $183,000


Types of Appraisals and Reporting Options Under

USPAP Types of Appraisals

◦ Complete appraisal◦ Limited appraisal

Reporting Options◦ Self-contained appraisal report◦ Summary report◦ Restrictive report


1. Letter report

2. Form report

3. Narrative report

4. Review appraisals

5. Real estate analysis


Certified General Appraiser Certified Residential Appraiser State licensed appraiser Provisional licensed real estate appraiser Appraiser trainee


Principle of Anticipation

Principle of Substitution

Highest and best use of a property

Principle of competition

Principle of supply and demand

Principle of change

Principle of contribution

Principle of conformity

Principles of Value


Characteristics of ValueCharacteristics of ValueDUSTDUST

DDemandemand

UUtilitytility

SScarcitycarcity

TTransferabilityransferability

Need or desire for Need or desire for good/servicegood/service

Ability of good/service Ability of good/service to fill needto fill need

Good/service must be Good/service must be in short supplyin short supply

Good/service must be Good/service must be available to marketavailable to market


Principles of ValuePrinciples of Value AnticipationAnticipation

SubstitutionSubstitution

Highest and best Highest and best useuse

Supply and Supply and DemandDemand

Diminishing Diminishing returnsreturnsand Contributionand Contribution

Price affected by expected Price affected by expected future benefitsfuture benefits

Maximum price is cost of Maximum price is cost of similar propertysimilar property

The use that gives the The use that gives the greatest value (competition). greatest value (competition). Consideration of immediate Consideration of immediate future uses.future uses.

Large supply lower price, Large supply lower price, low demand, lower pricelow demand, lower price

Try to invest at $1 for $1 Try to invest at $1 for $1 valuevalue


Market value Assessed value Insurance value Loan value Estate tax value Plottage value Rental value Replacement value

What is “Value”


Buyer’s market – excess supply of housing for sale.

Seller’s market – demand exceeds supply.


The American Institute of Real Estate Appraisers (AIREA)◦ MAI◦ SRA

Society of Real Estate Appraisers NATIONAL Association of Independent

Fee Appraisers Farm Managers and Rural Appraisers National Society of Real Estate

Appraisers American Society of Appraisers


Appraisal Capitalize Comparables Cost approach Depreciation FIRREA Gross rent multiplier

Highest and best use Income approach Market approach Market value Operating expenses Scheduled gross,

Projected gross USPAP

Key Terms

Chapter 18 ________________ Real Estate Appraisal

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